Canada Confirms Tokens May Be Securities and Pacific Coin Is the Test

Less than a month after the U.S. Securities and Exchange Commission (SEC) and the Monetary Authority of Singapore (MAS) each issued guidance regarding the application of their respective securities laws to token sales, Canada has weighed-in with a warning that largely is consistent with those nations' messages: issuers beware, tokens may be securities.

On August 24, the Canadian Securities Administrators (CSA), an organization composed of Canada’s provincial and territorial securities regulators, released Staff Notice 46-307 Cryptocurrency Offerings, which addresses how Canadian securities laws may apply to cryptocurrency offerings – a category that includes initial token sales and initial coin offerings, cryptocurrency investment funds and the cryptocurrency exchanges that trade such products.

In addition, the notice helps to clarify which tokens may be considered securities for the purposes of Canadian securities legislation.

A welcoming tone

Unlike the recent SEC report, the notice does not focus on a particular enforcement action or on a potential bad actor or fraudster.

Instead, the notice provides generalized advice to those contemplating raising capital via a token sale or creating a cryptocurrency investment fund and invites such businesses to reach out to local securities regulatory authorities to discuss ways in which to comply with Canadian securities law.

Indeed, the release accompanying the notice struck a welcoming tone, quoting Louis Morisset, CSA chair and president and CEO of the Autorité des marchés financiers, who said:

"The technology behind cryptocurrency offerings has the potential to generate new capital raising opportunities for businesses and we welcome this type of innovation. … Given the growing activity in this novel area, we are publishing guidance to help fintech businesses understand what obligations may apply under securities laws."

In the notice itself, the CSA refers to its regulatory "sandbox" and expresses encouragement for financial innovation, including with respect to cryptocurrency offerings, stating: "We want to encourage financial market innovation and facilitate capital raising by fintech businesses, while at the same time ensuring fair and efficient capital markets and investor protection."

It continues:

"As cryptocurrencies become more popular and mainstream, balancing the demand for new investment opportunities and the need to protect investors from high-risk or fraudulent activities is extremely important. In order to avoid costly regulatory surprises, we encourage businesses with proposed cryptocurrency offerings to contact their local securities regulatory authority to discuss possible approaches to complying with securities laws. We welcome digital innovation and we recognize that new fintech businesses may not fit neatly into the existing securities law framework."

'Facts and circumstances' test

Consistent with the recent U.S. and Singapore guidance regarding token sales, the notice does not state that all cryptocurrency offerings automatically will constitute trades in securities and, instead, explains that a facts-and-circumstances-type inquiry will apply.

The CSA notes that, in certain cases, a coin or token may be considered a security for the purposes of Canadian securities law, and that cryptocurrency offerings must be assessed individually to determine if they fall within the ambit of the legislation.

Crucially, the CSA notes that "in assessing whether or not securities laws apply, [the CSA] will consider substance over form."

The Canadian tests for what may be considered a security are, in many ways, similar to the U.S. securities analysis. Section 1 of Ontario's Securities Act (OSA) provides a lengthy but non-exhaustive definition of "security," which includes "any investment contract." This definition may capture a purchase of coins or tokens where the value of such coins or tokens is dependent upon the future profits or success of a particular business.

In Canada, the leading case for determining whether an investment contract exists is the Supreme Court of Canada's decision in Pacific Coast Coin Exchange v. Ontario (Securities Commission) ("Pacific Coin").

The four-pronged test announced by Pacific Coin is arguably based on the Howey test that exists under U.S. law.

Under Pacific Coin, an investment contract exists when there is:

An investment of money

in a common enterprise

with the expectation of profit

that comes significantly from the efforts of others.

Prior to the CSA's release of the notice, there had been some speculation in Canada that Canadian authorities might rely on the "family resemblance test" set out in "Ontario Securities Commission v. Tiffin" or adopt an entirely new approach for classifying and regulating tokens, coins, and cryptocurrency offerings.

The notice, however, seems to indicate that Pacific Coin remains the key case for determining what may constitute a security.

If an instrument satisfies the Pacific Coin test, it is an investment contract under Canadian securities law, and therefore a security for the purposes of section 1 of the OSA.

If a given token or coin is deemed to be a security under the Pacific Coin test, the applicable cryptocurrency offering for such token or coin may be classified as a trade in securities, in which case, Canadian securities laws would apply to the transaction.

The National Crowdfunding Association of Canada (NCFA Canada) is a cross-Canada non-profit actively engaged with both social and investment crowdfunding, alternative finance, fintech, P2P and online investing stakeholders across the country. NCFA Canada provides education, research, industry stewardship, and networking opportunities to over 1600+ members and works closely with industry, government, academia, community and eco-system partners and affiliates to create a strong and vibrant crowdfunding industry in Canada. Learn more at ncfacanada.org.